There is also another way that we can write that headline, which is that the Reserve Bank of India today decided not to lower interest rates as a result of the $170 billion in old rupee notes deposited into banks as a result of the demonetisation program. This is a substantial increase in the liquidity in the banking sector and the precise effect this is going to have on the money supply isn't really known as yet. Thus perhaps better to err on the side of caution than to possibly stoke inflation by reducing the interest rate.

The central bank said almost Rs. 11.55 lakh crore in old notes has been deposited back in the system. People have till December 30 to deposit old 500 and 1000 rupee notes in their bank accounts.

The withdrawal of old notes could result in temporary reduction in inflation by 10 to 15 basis points in the third quarter, RBI Deputy Governor R Gandhi said.

That could is really rather important there. Because we're really, really, not sure about this. If the velocity of circulation of black money was significantly lower than that of white or banked money, then while demonetisation has reduced the amount of cash in circulation it would in fact increase the wider money supply. And we just don't know what that velocity is or was and so just don't know the end result:

The six-member monetary policy committee (MPC), headed by the Reserve Bank of India (RBI) governor Urjit Patel, on Wednesday unanimously decided to keep the policy rate unchanged at 6.25%, considering the “heightened uncertainty” of volatility related to US rate hike and the local demonetization drive.

If we're uncertain then perhaps nothing is the right thing to do. The full announcement can be seen here and this is the important part for me:

Liquidity conditions have undergone large shifts in Q3 so far. Surplus conditions in October and early November were overwhelmed by the impact of the withdrawal of SBNs from November 9. Currency in circulation plunged by Rs 7.4 trillion up to December 2; consequently, net of replacements, deposits surged into the 3 banking system, leading to a massive increase in its excess reserves. The Reserve Bank scaled up its liquidity operations through variable rate reverse repo auctions of a wide range of tenors from overnight to 91 days, absorbing liquidity (net) of Rs 5.2 trillion.

Our estimates of the wider money supply, the one that influences inflation, come from the amount of cash in the economy times the multiplier of credit creation by the banks. And if the banks are flush with funds and we're not sure about the difference in the multiplier (which is largely the same thing as that velocity above) between banked and black money then, umm, well, maybe we should just wait and see?

Which is really what the RBI is saying here. We don't know enough to know the inflation effects of demonetisation. So, let's just wait until we do, shall we?

An entirely sensible course of action.

I'm a Fellow at the Adam Smith Institute in London, a writer here and there on this and that and strangely, one of the global experts on the metal scandium, one of the rare earths. An odd thing to be but someone does have to be such and in this flavour of our universe I am. ...